The Strategy That Returned 21% a Year for 43 Years - and 5 Small-Caps It Points To Now

Earl Weaver used to say that good baseball comes down to pitching, defense, and the three run homer. He did not put much faith in small ball. Bunting a man over, stealing a base, playing for one run at a time. Earl thought that was how you lost. He wanted his hitters sitting on fastballs and his pitchers around the plate, and he let the math do the rest.

I think about Earl a lot when I read academic finance papers, because most of them are small ball. 40 years of footnotes proving some tiny edge exists, worth a few basis points if you trade it perfectly and the wind is blowing out. Not this one.

A 2021 study out of the University of Texas, Huang, Zhang, and Zhou, looked at what happens when you stop choosing between fundamental strength and price momentum and start using both at once. They call it twin momentum. I call it the three run homer.

The results are spectacular, and easy to replicate. Let me show you how, and five stocks that have twin momentum forcing up their share price.

You already know price momentum. Stocks going up tend to keep going up for a while, until they do not. Wall Street has run that play since before Graham wrote a word about it.

Fundamental momentum is the quieter cousin. It is not whether a company is cheap or expensive. It is whether the underlying business, the actual return on equity, return on assets, earnings, profitability, payout policy, is accelerating or decelerating.

The twin momentum study built a composite score, a Fundamental Implied Return, out of seven of these variables tracked across one, two, four, and eight quarter windows. 28 inputs feeding one number. A report card that updates itself every quarter instead of waiting for the market to notice.

Here is the part that made me sit up. Price momentum and fundamental momentum barely talk to each other. The correlation between the two signals over the full study period sat around 0.18. That is two players on the same roster who almost never touch the ball at the same time. Which means when you put them together, you are not doubling up on the same bet. You are stacking two different ones.

Run them separately and price momentum returned about 0.87% a month over the 1976 to 2019 window. Fundamental momentum, almost the same, 0.85% a month. A coin flip between the two, statistically speaking.

Run them together and the combined strategy returned 1.81% a month. Not the sum of the parts. More than the sum of the parts. Annualized, that works out north of 21%, and the risk adjusted return, the Sharpe ratio, came in at 0.22 against 0.13 for price momentum running solo. The alpha survived every factor model the authors threw at it, Fama French five factor, Carhart four factor, the works. Nobody could explain it away.

I have read a lot of these papers. Most of them fall apart the moment you account for trading costs and the real world. This one did not. The study calculated that transaction costs would need to run above 2.06% a month before the edge disappeared entirely. That is a wide margin for a strategy trading actual securities and not just spreadsheet ghosts.

A bigger number does not impress me much on its own. I have watched too many hot strategies blow up the first time the market sneezed. What got my attention here was the shape of the losses, not the size of the gains.

Pure price momentum is a streaky hitter. Great until it is not, and when it slumps, it slumps hard, with a worst monthly drawdown north of 40% in the data and a return distribution skewed sharply negative. That is the guy who carries your fantasy team for three months and then strikes out looking in the biggest spot of the year.

Fundamental momentum is built differently. Its worst months came in closer to 24% and 29%, and when you blend the two together, the combined strategy showed almost no skew at all, 0.05, about as close to a normal distribution as you get in this business. Less prone to the kind of crash that wipes out three years of gains in three weeks.

That is the whole argument for community banks trading under tangible book, in a different jersey. You want the upside of a name the market has not caught onto yet, but you do not want to be the last man holding it when the story falls apart. Twin momentum is trying to solve the same problem from a different angle. Buy what is getting better, both in the business and in the price, and let the overlap do the filtering for you.

The study found the effect holds up even among the largest stocks in the market, which tells you the anomaly is real and not some statistical fluke confined to thinly traded names. But it is the small caps where this has always made the most sense to me, and where the data backs it up too.

Small companies fly under the radar of the analyst community. Nobody at the big shops is updating their model the day a small bank's net interest margin starts expanding again, or the day a regional industrial name starts winning back market share. The information takes longer to diffuse. The study actually measured this. Fundamental momentum keeps working out to 12 months before it fades, while price momentum tends to roll over after about four. That gap is the small cap investor's entire edge. You are getting paid to know a name before the rest of the world figures out the story is changing.

This is also where it ties back to the financials. Among the highest momentum portfolios in the study, banks and financial names were overweighted relative to the broader market. Rate sensitivity creates exactly the kind of inflection point that shows up first in the fundamentals and only later in the price. Sound familiar.

I am not going to stand here and tell you this is a free lunch, because there is no such thing, and anybody selling you one is selling you something else entirely.

Turnover on the combined strategy ran near 88% a month in the study. That is not a buy and hold approach. That is active, disciplined, somewhat mechanical trading, and it requires real infrastructure to execute without bleeding out on costs and slippage. The retail investor trying to hand pick twin momentum names off a screener once a quarter is not running the strategy the paper tested. He is running a watered down impression of it.

The other thing worth saying plainly. The study also found the edge gets fatter in high sentiment markets, better than double the return compared to low sentiment periods, and that should make you a little more careful right now, not less. A tailwind that strong eventually turns around and blows the other way. Marcus Aurelius did not trade momentum stocks, but he would have told you the same thing he told himself every morning. Expect the reversal. Plan for it. Do not be surprised when it comes.

What Huang, Zhang, and Zhou proved with 43 years of data is something old value investors have known in our gut for a long time. The market is slow to believe a business is actually getting better, and slower still to believe it twice, once in the numbers and once in the tape. Catch a name in both columns at the same time and you have found something the crowd has not priced in yet.

That is the whole game in small cap investing. Find the business before the analysts do. Find the inflection before the chart confirms it. And do not fall in love with either signal on its own, because alone they are both just decent hitters. Together, they are a lineup that can carry a season.

I built the Flagship Report around this exact intersection, deep value names with the fundamentals turning and the tape starting to agree. The academics just gave me a 43 year study to back up what I have been doing with a pencil and a stack of 10-Qs for thirty years.

Good to know the math finally caught up.

Theory only earns its keep when it points you at something real. Here are five small caps where the fundamentals are accelerating and the tape has started to notice. That is the whole game. Find the business getting better first. Let the price confirm it second.

This one delivered the kind of quarter that makes a value guy sit up. Record pretax earnings of $67 million, originations up 31% to $2.7 billion, and earnings per share that more than quadrupled from a year ago. Over 90% of loan originations now run on full automation, and management is pushing into home improvement lending through a new partnership while readying a rebrand to Happen Bank.

The stock popped 13% the day the numbers hit and has climbed better than 30% over the past quarter. Even after that run, shares still trade around nine times forward earnings, a discount to digital lending peers carrying similar growth. The fundamentals turned first. The price is still catching up.

Revenue jumped nearly 26% in the first quarter, adjusted earnings per share rose 74%, and management raised full year guidance on the back of facility reactivations and a new healthcare services acquisition. Occupancy across its facilities climbed to nearly 80%, up several points from a year ago.

Wall Street has noticed, with multiple analysts carrying strong buy ratings and price targets running well above where the stock trades today. There is real noise here, detention population counts can swing with federal policy, and management itself flagged a likely soft patch next quarter. But the longer trend, idle beds filling back up and a balance sheet built to absorb the bumps, is the kind of story twin momentum was built to catch.

A niche payments name most investors have never heard of, which is exactly the point. Revenue grew better than 50% in the first quarter, net income more than doubled, and operating margin expanded over ten percentage points year over year.

The growth engine is the patient affordability business, helping people afford prescription drugs, which grew 82% on its own. The stock has rallied nearly 66% over the past three months. That is fundamental momentum doing the heavy lifting in a name still flying well under the radar of the big shops.

Home turf for this newsletter. A community bank in Martinsville, Virginia that just sold off its largest pile of nonperforming loans and used the proceeds to scrub the balance sheet clean. Net income for the quarter came in at $85.8 million, inflated by the one time gain, but even the normalized number held up fine, and tangible book value jumped to $22.69 a share. Nonperforming loans fell to a clean 0.64% of the portfolio, capital ratios sit comfortably above well capitalized thresholds, and the stock is trading near its 52 week high after climbing more than 60% off the bottom.

This is the classic community bank turnaround. Clean up the credit book, let tangible book value do the talking, and let the market slowly figure out the discount no longer makes sense.

A lithium-ion battery maker building out from its core material handling business, more than ten thousand systems deployed in forklifts and industrial equipment, into the verticals that actually move a stock price these days: commercial robotics, defense, and energy storage. The most recent fiscal first quarter posted revenue up 39% year over year with gross margin expanding to 32.9%, and adjusted EBITDA up 265%. The following quarter kept the streak going, revenue up 20%, adjusted EBITDA up 41%, and an eleventh-plus straight quarter in the black.

Management is guiding to better than 30% revenue growth for the year, with a new cell manufacturing facility in Jamestown, New York coming online and a Department of Energy backed storage initiative moving forward. Roth Capital has been chasing the story higher with its price target, most recently lifted into the high teens with a Buy rating intact. The stock has been one of the strongest movers in this group over the past year. Small, under covered, and exactly the kind of name twin momentum is built to find before the rest of the Street does the homework.

These five names are a starting point, not a portfolio. They are where the business and the price are both accelerating right now. But twin momentum is not a once-and-done exercise. The fundamentals shift every quarter, the tape moves every day, and the whole edge is staying with the names while the signal is live and stepping aside when it fades.

That is what the Flagship Report's Small-Cap Momentum portfolio does, every month, on a disciplined model that has beaten the market 16 of the last 20 years. Most investors are stuck with wherever the S&P 500 takes them. Flagship subscribers own a system built to find the breakout names first - in up years, down years, and sideways years.